Activision Blizzard: A Long-Term Stock With a Business Model Even I Get

One of the first books I read was The Motley Fool's Rule Breakers, Rule Makers. In it, Motley Fool co-founder Tom Gardner laid out specific criteria for crowning a company a Rule Maker: a mature, consumer-facing business that's king of its market space, and an investment that can confidently and profitably be held onto for years with only quarterly check-ins.

His step-by-step process for analyzing a business was an easily understandable way for a beginner like me to quickly get up to speed, but its back-to-basics approach will benefit even advanced investors. Today we're going to run video game publisher Activision Blizzard (Nasdaq: ATVI) through Tom's merciless gauntlet and see exactly what makes it a classic Rule-Maker.

1. The mass-market, repeat purchase of low-priced goodsDo you know what World of Warcraft is? Call of Duty? If so, then you know Activision Blizzard, the publisher of these extraordinarily popular video games. Activision Blizzard makes titles for Nintendo's Wii, Microsoft's Xbox, and Sony's (NYSE: SNE) PlayStation and is the world's No. 1 video-game publisher.

The games aren't exactly cheap, but at $59 for the latest version of Call of Duty for Xbox, they're not terribly expensive, either. As such, when updates are released, fans rush out and scoop them up. So Activision Blizzard clearly makes mass-market items at reasonable enough prices to keep consumers coming back for more. Well done on our first Rule-Maker benchmark, Activision.

Rival game publisher Electronic Arts (Nasdaq: EA) does very well, too, with a trailing-12-month gross margin of 62%.

Sony manages only a 20% gross margin, but Sony does a lot more than just publish software; it's much tougher to have a high gross margin when you're manufacturing hardware. Even Apple (Nasdaq: AAPL) hits only 44% on this metric, and it runs one of the leanest, meanest hardware manufacturing operations in the business. As such, we'll cut Sony some slack here.

3.Net-profit margin Net-profit margin dictates how many pennies a company gets to keep from every dollar of sales. Tom Gardner likes to see net-profit margins of 10% for his Rule Makers.

Activision's net-profit margin TTM is a positively whopping 19.89%.

Electronic Arts' net-profit margin TTM is a positively unwhopping 0.37%. That's worse than some supermarket chains, which can have some of the slimmest profit margins of any industry.

Sony is apparently losing money on all it's sales right now, with a net-profit margin TTM of -6.97%.

4.Sales growthYear-over-year sales, or revenue, growth counts even for big companies, where it will naturally slow with age, because it's an indicator of business momentum. Top-tier rule makers grow their sales by 10% every year.

Activision grew its year-over-year quarterly sales by a Rule-Making 11.5%.

Electronic Arts YOY quarterly sales actually contracted by 0.6%.

Sony grew its YOY quarterly sales by 1.9%, which is better than no growth at all or negative growth.

5.Cash-to-debt ratioRule Makers should be cash heavy and debt light, ideally having at least 1.5 times more cash than debt:

$3.4 billion in cash and zero debt gives Activision the best cash-to-debt position possible.

$1.3 billion in cash and $549 million in debt gives Electronic Arts the enviable C/D of 2.37.

$5.4 billion in cash and $16.2 billion in debt gives EMC the unenviable C/D of 0.33.

Money is so cheap right now. As such, too many companies are in debt up to their corner offices. Kudos to two of our companies for keeping their balance sheets in top Rule-Making trim.

6. The Foolish Flow RatioThe Foolish Flow Ratio measures how well a company manages its inventory and cash. A company should be keeping its inventory and accounts receivables low and its accounts payables high: strong indicators of market-space dominance.

To calculate the Foolish Flow Ratio, take current assets minus cash, cash equivalents, and short-term investments, then divide by current liabilities. The acceptable upper limit for the Foolish flow ratio is 1.25, but the lower the number the better:

Activision comes in very solid on this metric, with an F/F of 0.77.

Electronic Arts also does even better, with an F/F of 0.50.

And Sony comes in with the best F/F of all: 0.48.

7. Your familiarity and interestWhat's in a name? Quite a bit. Your familiarity and interest with a company help you understand exactly what it does and how it makes money, thereby lowering your overall investing risk.

Activision Blizzard isn't the big name here so much as the names of the titles the company publishes, but it's still a well-enough known name in and of itself. And the company's business model is dead easy: making and publishing video games. The company scores solid, then, on this final Rule-Maker benchmark.

Activision Blizzard: above and beyond the call of dutyActivision doesn't miss a beat on any of our Rule-Maker metrics. As such, there's no question the video game publishing superstar is also a classic Rule Maker. But always remember to check in on your Rule-Maker investments once a quarter by running them through this simple checklist. In Rule Breakers, Rule Makers, Tom Gardner goes into even greater depth and detail about what exactly makes a Rule Maker a Rule Maker. So I suggest you pick up a copy for yourself and get the whole story from the man who wrote the book on it.

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Fool contributor John Grgurich owns no shares of any of the companies mentioned in this column. Follow John's dispatches from the bleeding edge of capitalism on Twitter, @TMFGrgurich.

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Activision is also one of the most hated names in the video game publishing/developing industry, and not without reason.

I wouldn't be surprised if Activision (and EA's) propensity for quashing innovation, over-milking of franchises, and driving off talent, while still finding the time to make arrogant and clueless comments about it all, eventually becomes a detriment.

They're doing fine now. I won't argue that.

I just can't get behind the idea of investing in a company that behaves as Activision (or EA) does. There has to be some backlash for that eventually.

Personally, I don't buy new games from either company anymore.

I don't delude myself into thinking this actually matters in the big picture, but I also don't think I'm alone here.

Ultimately, an investment in Activision, or EA, is in investment in cynicism.

There are plenty of companies, and indies, out there that have figured out better ways to make games, deal with their fans, and still make money.

A long term stock would require a bright future, little competition and product lines that will sell.

For ATVI to be a long term stock they've got to over come a few obstacles. Why would anyone in their right mind consider the following over 'past numbers' and bank their long term future with the company?

-ATVI must face increasing competition from mobile and social, Does not favor ATVI long run.

-Carrying on with not so clean reputation,

-Plus their cashcow/bread and butter WoW subscription is in decline; MMORPG is not 'in' anymore. Does not favor ATVI long run.

-Gaming and entertainment industry is shifting, people are finding different ways to entertain themselves. Definitely does not favor ATVI

-Having no debt and CASH does not sell your products.

Sure if you look at how much cash ATVI has on them right now, one may view that it's a sign of healthy business. It's just that at best really.

Having cash does not sell products. Having no debt does not make them immune from increasing competition in entertinament. Yes, more people are jumping onto mobile and social gaming. EA and other developers for pc/console games aren't the only competition here.

ATVI itself knows very well of its competition and their business models; micro transaction base.

It has been well proven that micro transactions are generating more revenues than traditional '$xx dollars per pop + expansions to come' business model. So much so that ATVI experimented with their latest Diablo franchise. What is alarming is that they did not release their revenue number on RMAH.

Let's also look at sales growth number. What does it really mean? it means that ATVI has been pumping out some of their big name franchiese, Skylander, CoD, Diablo AND WoW, but only manage to increase sales growth by a marginal number. You'd think they'd done better with their big title releases. Alarm bells are ringing. I thought each and one of them were meant to be giant ground breaking success?

Don't forget that ATVI doesn't exactly have the best reputation nowadays, Management has been criticized for 'cash grab' rewashing of franchises, as much as units sell, you lose customers, and customer retention cost way too much nowadays. D3 in particular had a huge hiccup, and it doesn't matter what the company numbers show, it is not a good sign.

MMORPG is no longer the hip thing. Huge amount of Blizzard revenue is/was from their subscription business model of WoW. It was the hip thing back then, not so much now.

Regardless the reason behind why the game is in decline, it's not going to increase revenue LONG TERM. WoW had a great thing going, you launch, and do some marketing and promo, generate revenue for years to come. Much more profitable than spending millions and millions on a new product, print out the dvd, ship em out, sell em, have them sell at $60, give retailers a cut etc.

Yes cash flow and debt level does matter, but what good is current profit margin and flashy numbers if your time line in the future doesn't look all that 'flashy'.

Thing's aren't exactly going ATVI's way, Sure they 'can' turn it around, but who's confident enough to get on their boat when there are other safer long term boats?